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Bank of England should leave forecasting to Ladbrokes

Last week former Federal Reserve economist David Stockton’s report on Bank of England’s forecasting track record was published. City AM had this wrap-up (I didn’t read the report yet):

“INFLATION has been damaging British living standards and dragging down the economy – but the officials who are meant to keep a lid on prices didn’t do enough to help because their forecasts were too often wrong, according to a Bank of England report out today.

And even though the Bank was consistently worse at predicting changes in growth and inflation than other economists, it stuck with its flawed model, making excuses for its errors instead of trying to improve its forecasts.”

I would probably be less critical about that Bank of England’s forecasting abilities – or rather I know how hard it is to forecast anything, but I am not surprised to learn that Stockton find that BoE’s forecasts are biased. In fact I would be surprised if he had found that it was not biased. Central banks have strong incentives to do biased forecasts – and sometimes that might actually be what you want central banks to do. I for example find it very odd when central bank forecast that they will fail in achieving their policy objectives, but I also realize that central banks fail to hit their policy targets all the time.

David Stockton has 21 ideas to improve BoE’s forecasting abilities. Some of Stockton’s ideas are probably good, but I think that there is a more fundamental problem – and that is that central banks’ in-house forecasts very likely always will be biased. Therefore central banks should outsource forecasting – not because other institutions or companies (like banks!) necessarily are better at making forecasts than central banks, but because the forecasts of “outside” agents is likely to be much less biased than a in-house forecast.

One way would be to simply to outsource the forecasting to a private research company. Another possibility would be to base the forecast on a survey of professional forecasts – or even better as I have suggested numerous times that the central bank simply set-up a prediction market. In Britain that would be extremely easy – I don’t think there is a country in the world with so many bookmakers. The Bank of England could simply ask a company like Ladbrokes or a similar company to set-up betting markets for key macro economic variables – such as inflation and nominal GDP. It would be extremely cheap and the forecast created from such prediction market would likely be at least as good as what is presently produced by the otherwise clever staff at the BoE.

7 Comments

Mysjkin

This is of topic but I would like to know your opinion about it. In the nineties Russia and Ukraine had very large decreases in real GDP but at the same time they managed to spectacularly increase the nominal GDP. What could we learn from their experience, as they were so succesful in maintaining NGDP growth? What do you think?
Here are the data:

Furthermore, I would stress that high growth of NGDP certainly should not be an objective on its own – Germany had very high growth in NGDP in 1923 as do Iran have now. That is hyperinflation. The central bank should ensure a STABLE growth of NGDP and we know when we get high inflation/NGDP growth it tend to be high erratic. This is exactly what happened in Russia and Ukraine in the 1990s. NGDP growth was high, but highly volatile and therefore completely unpredictable – which most likely had serious NEGATIVE impact on RGDP growth.

Stable and predictable NGDP growth will also ensure the best environment for investment and business decision and as such contribute positively to RGDP growth in the long run.

Mysjkin

Thank you for your answer. I do have a problem with your assertion that it is ‘a deterioration of the protection of property right and the rule of law’ that caused the decrease of Ukraine’s and Russia’s RGDP in the nineties. They came from a situation (Soviet Union) where there were no property rights at all and I think you’ll agree with me that the rule of law in the Soviet Union was also not very strong. So surely there must be other factors than regime uncertainty that caused such heavy declines in RGDP?

I certainly do not mean to imply that the Soviet Union provide any protection of private property right and there was certainly no respect for the rule of law. However, with the end of communism and the collapse of Soviet Union uncertainty about the general legal and institutional framework increased dramatically.

I think that the collapse of communism was a massively positive event – socially, culturally, politically and economically, but the transition was far from “orderly” in Russia and Ukraine – contrary to for example in Poland where the “transitional uncertainty” was far smaller than in Russia and Ukraine.